Question

You’re trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $22.6 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $2,015,000, $2,245,000, $2,234,000, and $1,426,000 over these four years, what is the project’s average accounting return (AAR)? (Do not round intermediate calculations and enter your answer

Answer 1

The Average Accounting Return (AAR) for the new manufacturing plant is calculated by dividing the average annual net income of $1,980,000 by the average investment value of $11.3 million, resulting in an AAR of approximately 17.52%.

Step-by-step explanation:

The student is asking how to calculate the Average Accounting Return (AAR) of a new manufacturing plant investment. To find the AAR, we need to average the net income over the life of the project and divide it by the average investment value. Since the installation cost is depreciated straight-line to zero over its four-year life, the average investment value is half of the initial cost (due to straight-line depreciation), which would be $22.6 million / 2 = $11.3 million.

The sum of the projected net income over the four years is: $2,015,000 + $2,245,000 + $2,234,000 + $1,426,000 = $7,920,000. The average annual net income is then $7,920,000 / 4 = $1,980,000. Therefore, the AAR is calculated as average annual net income ($1,980,000) divided by the average investment value ($11,300,000), which gives us the AAR = $1,980,000 / $11,300,000 ≈ 0.1752 or 17.52%.